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Indian Market Perspectives: Sell on a Rise or the Beginning of a New Cycle?

Why Are We Positive About India?

Indian markets today are a classic story of excessive exuberance of post-Modi's election victory in 2014, giving way to almost utter pessimism as countries battle with the COVID crisis. History has shown that extremely excessive optimism and pessimism are good contrarian indicators in India from a stock return perspective. We have maintained that the execution of the promise does happen in India, though the pace is generally slow compared with China. Hence, the expectations needed to be realistic.

The Modi government for the past five years has worked on strengthening the institutional framework, including India's digital economy, infrastructure connectivity, ease of doing business, and financial inclusion. The beneficial outcomes will be at a slow pace, but they will provide a long-lasting growth impetus to the economy once the COVID situation begins to normalize.

COVID-19 Update

The daily new case has inched up to 10k, totaling over 260k cases and growing at 4.3%1. Daily tests of 141.7k took total tests to almost 5mn1. Despite a large number of total confirmed cases, a silver lining is that COVID deaths are at 7,745 with a fatality rate of 3% while the recovery rate is nearly 50%, and more than 135k patients have recovered1.

To put it into perspective, daily deaths from COVID of 280 is ~1.2 % of total mortality (from all causes) in India1. The four most affected states - Maharashtra, Tamil Nadu, Delhi, and Gujarat - account for 64% of total cases. Outside the above deeply impacted containment regions, life is slowly returning to normal. As the economy opens up, the administration's priority is on addressing medical needs of around 5% of COVID patients who need hospitalization and adequate quarantine facilities for the symptomatic ones while being well aware that nearly 80% of cases are asymptomatic.

We believe that greater parts of the economy come out of the lockdown. As we see that Hong Kong, China, and Korea move towards normalization of economic activities, markets will focus on valuing these businesses as going concerns rather than factors in excessive pessimism.

What Gives Us Comfort in Recovery?

1) Strong Global Stimulus and Easy Monetary Conditions

Unlike the global financial crisis in 2008, central banks and governments have responded quickly with measures to mitigate the lockdown impact and stabilize the financial system.

The USA and Europe lead the world in stimulus on the monetary and fiscal front. Their reserve currencies give countries more firepower. While the US stimulus is led by Republicans controlling the Government and 2020 presidential elections, the European stimulus of €1-1.5tn is a result of Franco-German's efforts of keeping the European Union intact.

Locally in India, a sharp improvement in forex reserves with nearly 17% increment since January 19, ensuring adequate and ample domestic liquidity. Unlike tight cashflow in mid-2018, the Indian banking system has sufficient liquidity that banks regain confidence. The lending activities have already been started visibly from April low.

Economic Recovery before COVID in Jan and Feb

Before the lockdown in late March, the economy was on a recovery path with strong electricity generation and fuel consumption data. We believe, in the absence of large scale job losses for white-collar workers, limited spending and high savings, and the pursuit of high quality of life during lockdown, consumer demand should bounce back strongly in the coming months. Banks have already been partnering with consumer/e-commerce companies to offer highly attractive initiatives to attract consumers.

End of Lockdown, Tidbits from the Ground

India started lifting the lockdown measures gradually in early May that the initial high-frequency data points are encouraging. E-way bill generation reached 77% of pre-COVID rates in the last week of May. Retail electronic transactions (UPI, IMPS, CTS) by value are at 78% of Feb '20 levels, while inter-bank transactions (RTGS, NEFT) are higher than Feb '20. Despite limited new content, ad-spot level standing at 84% of normal is encouraging and indicates the supply-chain restoration.

Stimulus Package with a Focus on Self-Reliance

The Indian Government recently launched the Self-Reliant India Mission, Rs20.9tn (US$275bn) program, comprising of several relief measures and long-term structural reforms in the labor and agricultural sectors. These measures aim to fight against the economic challenges posed by the COVID-19 crisis, as well as leverage the structural opportunities it presented.

The initial fiscal measure of Rs1.9tn (US$25bn) intended to buffer the lockdown impact through a series of income support measures including cash transfers, free food grains, gas cylinders, and interest-free loans to help low-income households. On the monetary front, RBI liquidity measures amounted to Rs8tn (US$105bn).

Further fiscal measures were later announced, bringing the overall sum of the five tranches to Rs11tn (US$147bn) or 5.2% of GDP. In addition to the initial measures, the final sum of the overall economic package comes to Rs20.9tn (US$275bn) or 10.1% of GDP. In our view, the immediate net fiscal impact from the overall economic package will be limited at 0.7% of GDP.

We believe the measures implemented for MSMEs will significantly keep these businesses afloat in the near-term and should cushion the effects of lockdown laws as a result of COVID. With the majority of the Indian market comprising of MSMEs, the stimulus package is expected to benefit over 63 million corporations. We are positive with the Government's efforts to provide ample liquidity into the market as a liquidity crunch is a big overhang on investor's minds.

Key to Sustaining a High GDP Growth Rate in the Medium Term

Kickstart Investment Cycle – the single most crucial factor for growth recovery and sustainability. Initially, we may see large scale infrastructure programs that Uttar Pradesh is developing expressways to boost growth and deploy excess labor. In 2021, post recent labor market reforms, we may see FDI in India picking up on the back of US-China trade tensions, the low corporate tax rate of 18%, and the lure of a large captive market. A notable success of the Modi Government's Make in India campaign has been the electronics industry where India today assembles 350 million smartphones. In the future, the focus would be on capturing greater parts of the value chain and a share of the high-end manufacturing rate of 15% for new manufacturing companies. This rate is lower than that of China and other regional countries.

Recap of the Financial Sector – bulk of the private banks in India are well-capitalized. Though some may raise excess capital to exploit M&A opportunities, the Government gives SOE banks capital.

Our Positioning

We are positioning for economic recovery and overweight consumer cyclical such as financials, real estate, and consumer discretionary.

P/B ratio of ex-consumer staples for Indian sectors drops at the GFC low. India's premium to EM is at the lowest point in the past 15 years. The change in aggregate foreign portfolio limits to sectoral caps that will lead to higher MSCI & FTSE weights and attract incremental flows of US$5-8bn over the next 12 months.

We believe that as the economy reopens in the coming weeks, the Government's economic package, combined with the RBI's aggressive monetary easing, should ensure recovery in the coming quarters. Besides, spending on infrastructure and demand for private housing should benefit the industrials sector. This should provide a positive backdrop for well-capitalized banks like HDFC Bank, ICICI Bank, and hence we continue to maintain our largest overweight position in the financial sector. In the energy sector, we continue to be optimistic about Reliance Industries. Although it is classed as an energy stock, we hold it for its telecom and retail business as to where the room for value creation is huge on the back of capturing a higher market share of consumer wallets through big data analytics focused "Super App."

We are confident in selecting health care, industrial, and consumer discretionary names. These companies, although small, are leading companies in their respective opportunity spaces including hospitals, logistics, consumer durable, and retailing. In recent years, a significant detractor to our performance has been attributed to an underweight position in consumer staples. P/E multiples have continued to expand and now trade significantly above mean valuations. At the same time, mid and small caps have been over-weighted, that bore the brunt of economic uncertainty.

"With historic low-interest rates, little economic excesses, and rock-bottom GDP growth rates, we believe there will be a reversal in the coming years and be a significant alpha generator for the portfolio. Finally, to protect the downside risk to the portfolio, we continue to back industry-leading management with strong balance sheets ".

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1 Source: Mirae Asset Global Investments, as of June 9, 2020.

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